The seven habits of highly effective watchdogs

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

By Rob Cox

The 2008 financial crisis revealed many of the world’s banking regulators to be woefully ineffective. Sheila Bair’s five-year spell at the helm of the U.S. Federal Deposit Insurance Corp, which ends on Friday, may offer a potential exception. A potted banking regulator’s version of the 1989 self-help tome, “The Seven Habits of Highly Effective People,” sums up Bair’s tenure.

Know your goals and limitations. The FDIC has some advantages over many other watchdogs. Its relatively clear remit is to protect bank depositors’ interests, and it is funded by premiums levied on banks rather than being beholden to Congress. A major goal is to minimize losses to its insurance fund. Though increased premiums can bring more money in over the long term, the agency’s short-term tools are limited to transactions with the private sector and the bully pulpit. Bair used both to the full.

Nurture private capital. When the crisis forced the FDIC to shut down banks, it needed to bring in private-sector money to recapitalize the sector. It wasn’t easy — investors like private equity firms TPG and Warburg Pincus had already been burned. But early on the FDIC engineered the sale of IndyMac’s assets to JC Flowers, Paulson & Co and others, and the purchase of BankUnited by a group led by veteran banker John Kanas. These helped entice private money, and eventually healthy banks, into the sector.

Minimize giveaways. The IndyMac and BankUnited deals looked, in retrospect, too sweet for the buyers. BankUnited tripled its backers’ money when it went public earlier this year. But the FDIC soon closed the door on easy pickings — a decision that had private equity firms howling. By then the flow of private capital was under way, and despite less attractive terms the agency was able to sell other failed banks. Bair’s team even found a way to claw back a slice of the upside on some deals.

Stand up to bankers. Bair was never one to shrink from a fight with bankers — or other regulators. Indeed, the fact that Bair made so many adversaries may be a virtue of its own. Ask Vikram Pandit, the Citigroup chief executive. The FDIC played a pivotal role in up-ending Citi’s attempt to buy Wachovia in October 2008. As Citi’s negotiators quibbled over the details of their $1 a share purchase backed by government guarantees, Wells Fargo swooped in with a $7 offer without state help. Bair not only egged Wells on, she informed Wachovia’s chief of the bank’s bid.

Fight for your relevance. Ned Kelly, a senior Citi executive who worked on the Wachovia deal and took over as chief financial officer, publicly called the FDIC a “tertiary regulator.” That didn’t sit well with Bair. The FDIC questioned whether Citi had the right executives in place to ensure the safety of its depositors’ cash. In short order Kelly was no longer CFO and, among other changes, Citi named veteran retail banker Eugene McQuade to run its core depositary business.

Inflict pain on dumb investors. Shareholders are almost always wiped out when the FDIC seizes a bank. But Bair went a step further when the agency took over Washington Mutual. Subordinated and senior debt holders of the $300 billion-asset thrift were not rescued when JPMorgan bought WaMu’s branches. That bold decision woke sleepy bond investors up to the idea they would not always be bailed out.

Provide comfort to the needy. While Bair didn’t spare banks and executives that, she felt, threatened the FDIC’s goals, the agency did offer the critical Temporary Liquidity Guarantee Program when credit markets dried up in October 2008. The program allowed institutions like Citi and GE Capital to finance their businesses by guaranteeing debt they issued — some $350 billion of it — for a fee. Yet even here the FDIC was selective in its approach. It did not, for example, allow lender CIT to use the TLGP. In the end, the program looks as though it has made money.

Of course, in hindsight Bair — like so many other regulators around the world — arguably didn’t make enough fuss as the financial bubble inflated before the crisis. In handling the fallout, though, Bair made the most of her own and the FDIC’s qualities to display what might be called “The Seven Habits of Highly Effective Watchdogs.”